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Franchise Law Update

Commentary on Business and Legal Issues of Franchising

South Korea Fair Trade Commission Imposes Huge Penalty on Franchisor

Posted in International Franchising, Legal Decisions

The South Korea Fair Trade Commission (“SKFTC”) recently imposed the maximum possible penalty—1.9 billion won (approximately US$1.88 million)—on a South Korean franchise for violating the Fair Transactions in Franchise Business Act (the “Act”).  Caffe Bene, a company with over 1,860 stores in fourteen countries and valued at 176.2 billion won (approximately $171 million), incurred the fine for passing disallowed costs on to its franchisees.

The penalty—the largest ever imposed by the SKFTC—demonstrates its intent to aggressively pursue Act violations and comes soon after major amendments to the Act early this year.

The violation stemmed from a partnership inked between Caffe Bene and KT Corporation (formerly Korea Telecom; “KT”).  The agreement offered 10% discounts to KT subscribers and split the costs equally between Caffe Bene and KT.  Despite opposition to the promotion by 40% of its franchisees, Caffe Bene forced its franchisees to implement the promotion and absorb the losses.  According to the SKFTC, Caffe Bene’s actions violated by the Act and its franchise agreements, which allocated marketing and promotion costs equally between Caffe Bene and its franchisees.

The SKFTC’s investigation further revealed that Caffe Bene required franchisees to redesign their stores, pay for “necessary equipment” from headquarters or a designated third-party, and purchase items that the franchise agreements designated as “optional.”  These practices generated 181.3 billion (approximately $176 million) in interior remodeling and equipment sales to franchisees between November 2008 and April 2012, accounting for nearly 56% of Caffe Bene’s total sales during that period.

This case is clearly an egregious case because the SKFTC’s findings were that the franchisor violated both the Act and its own franchise agreements. That said, it also highlights the risk/reward inherent in international franchising. We’ve all heard it before, but it bears repeating:  the failure to work with experienced local counsel, whether you are a domestic franchisor going abroad or an international franchisor coming to the United States, is dangerous. Here, it appears that significant changes to the South Korean Act were missed. While good counsel does not ensure success, it definitely helps to manage that risk.

Urgent Hotel Wi-Fi Security Warning

Posted in Business Updates, Uncategorized

Every business uses the internet. Especially franchised businesses with far flung operations working together to promote the brand. So, this latest Wi-Fi security warning is relevant to all of us.

Kaspersky Lab–one of the leading internet security companies–has issued an urgent security warning to business executives travelling to the APAC region. The concern is that there is an internet espionage campaign nicknamed “Darkhotel” targeting top US and Asian executives staying at luxury hotels.

The installation is very sophisticated. After logging into the hotel’s Wi-Fi network, the attackers trick the victims into downloading and installing a backdoor that pretends to be a update for legitimate software, such as Google Toolbar, Adobe Flash, or Windows Messenger. The malware installs a Trojan program, advanced keylogger and an information-stealing mode. These tools are used to capture system information, steal keystrokes and hunt for cached passwords. Kaspersky also found that the malware has been used to steal intellectual property from the victim’s companies. Most insidiously, once finished, the attackers carefully delete their tools and go back into hiding.

What can you do to protect yourself? As we have previously noted, being proactive is the best strategy:

  • Use a Virtual Private Network (VPN) so that your communications are encrypted when accessing public or semi-public Wi-Fi (such as hotel networks).
  • Regard any prompt to update software when using a public Wi-Fi network as suspicious. Moreover, you should always confirm that the update installer is digitally signed by the software vendor.
  • Make sure your Internet security solution is proactive against threats, rather than purely defensive or basic anti-virus protection.

These steps will go a long way to protecting yourself and your brand from malware attacks.

Franchise *Disclaimer* Document? Or, What Is an Attorney’s Duty regarding the Estimated Initial Investment Disclosure? Seattle ABA Forum on Franchising Annual Meeting Takeaway.

Posted in Drafting Tips, Regulatory Compliance

An interesting and lively discussion arose between “franchisee attorneys” and “franchisor attorneys” in the audience during a presentation on FDD Drafting at this year’s ABA Forum on Franchising Annual Meeting in Seattle.  The issue centered around the initial question of whether a franchisor should keep the ranges of costs in the Item 7 Estimated Initial Investment table tight and eliminate any outliers that make the low and high estimate too broad.   The rationale for this position is that the very low or very high outliers may not be a real or accurate representation of the true costs a supermajority of franchisees will incur.  In addition, a range too wide degrades the purpose of the disclosure.

Some audience members said they addressed this issue by keeping the explanations clear in the footnotes and eliminating atypical expenses.  For example, many franchise systems specifically do not include real estate purchase costs if most franchisees in the system lease and do not buy land.   One attendee pointed out that most Item 7 footnotes also contain numerous disclaimers to make sure that a franchisee knows that its own expenses may vary.

The discussion then quickly moved onto whether a franchisor’s counsel has a duty to  investigate and/or provide franchisor clients with advice regarding whether the Item 7 estimate ranges are accurate and couched in fact.  A franchisee attorney in the audience pointed out that an FDD is not a Franchise Disclaimer Document and a franchisor should not be able to avoid sloppy work by disclaiming away the estimates.  Franchisor attorneys quickly responded that an FDD is also not a Franchise Guarantee Document and it is not fair to presume that every franchisee can expect to fall within the range every time.

What if a start-up franchisor or international franchisor expanding to the US does not properly hire a consultant or otherwise  undertake the proper research to make reasonable and responsible Item 7 estimates?  I work with many start-ups and international franchisors moving into the US.  In each case I do make it a practice to point out any abnormally broad ranges or estimates that look wildly inappropriate while still making it clear that I am not an expert such projections.  Moreover, I encourage what I think is the best practice of hiring knowledgeable consultants for this purpose.  Obviously this is a hot-button topic and it was interesting to hear the varying opinions by different franchise practitioners at the Annual Meeting this year. I’d be interested to hear your thoughts in the comments below.

NLRB General Counsel Explains Controversial McDonalds Recommendation

Posted in Industry Updates, Legislative Updates

National Labor Relations Board General Counsel Richard Griffin has come under fire recently for not issuing a memorandum explaining and detailing his rationale for his controversial recommendation this past July that McDonalds could be treated as a joint employer with its franchisees.

While still not releasing a written report or memo, Mr. Griffin finally spoke on the matter last week at a West Virginia University College of Law event.  Mr. Griffin categorized the “joint employer” issue as one of four “law reform efforts” happening at the NLRB.   Mr. Griffin relayed the history of the “joint employer doctrine” and stated that from 1935-1985 the NLRB applied a less stringent standard test he calls the “Traditional Test.”  Under the Traditional Test, the NLRB analyzed whether the “putative joint employer had a direct or indirect effect on the terms and conditions of employment and right to control.”  The right to control  “didn’t have to be actual, it could be potential – in other words, it could be a contractual relationship between the two entities that gave one of them authority to do something” and it wasn’t necessary under the NLRB  prior law that the entity had the authority actually do it – just that it had the authority to do it.

Then in 1984, according to Mr. Griffin, the NLRB ratcheted up the standard.   The test became one where a putative joint employer must have a direct and immediate impact on substantial terms and conditions of employment.  Moreover, such control has to be actual – not potential.   Mr. Griffin wants to return to this Traditional Test and states that one of the types of situations that calls out for this Traditional Test is in the area of franchisee-franchisor relationships.

However, he also explained that even when previous NLRB general counsels would authorize complaints against franchisors, the NLRB (using the pre-1985 Traditional Test) would not find the franchisor a joint employer if the franchisor’s indirect involvement resulted from the franchisor trying to protect the uniformity and quality of its brand.  In other words, if a franchisor was simply taking action to protect its brand then it was insufficient involvement to find a franchisor a joint employer with its franchisee.

Mr. Griffin explained that he does not want to overturn those earlier cases but found that many of the new cases go beyond a franchisor simply protecting the uniformity and quality of its brand.  He pointed to new software capabilities that monitor everything happening at the franchise level in real time including keeping track of minute-by-minute gross sales and labor costs.  Such information allows a franchisor, for example, to “dictate” when employees should be sent home.  Mr. Griffin argues that it is this type of involvement in employee hours, terms and conditions of employment that goes beyond protecting the brand and in those cases the franchisor should be a joint employer with the franchisee. Of course, where some see “dictates” others can very well see “good guidance” and “suggestions”.

Considering the breath of information that modern technology makes available to franchise systems, it will be interesting to see where the NLRB ultimately draws the line.

The full video of Mr. Griffin’s speech is available here.

Continuing Growth of Professional Athletes in Franchising Featured in National Media

Posted in Articles, Business Updates, Industry Updates, Start-Up and Emerging Franchisors

 

We have blogged in the past about the Professional Athletes Franchise Initiative (PAFI), an organization that connects the professional athlete community to the franchise industry through education, research and interaction.  Fox Rothschild is a Charter Member of PAFI and it is an  official affiliate of the International Franchise Association.  This week the Wall Street Journal small business section featured an article promoting the proliferation of both current and retired professional athletes in the franchising industry stating “over the past few years, pro athletes have become a rising presence in the franchise world.”   The article cites well known personalities Peyton Manning, Jamal Mashburn and Junior Bridgeman as examples of famous professional athletes who have found success with franchising.   You would be hard pressed to find someone who has not seen a Papa John’s commercial featuring Peyton Manning.  But Peyton is not just a spokesperson - he is also a Papa John’s franchisee.    To further ensure success many franchisors will match an athlete who would like to invest in a franchised business with an experienced franchise manager as Papa John’s did last year with former football great Jerome “the Bus” Bettis.  According to the article,  the mix of capital and strong marketing power is attractive to franchise systems.   

PAFI’s programs work to educate the athlete about the business of franchising and are a good place for athletes serious about their future and franchise systems wishing to attract athletes to start the process.    

 

 

Watch Where You Place That Pickle! NLRB Rules Against Burger King Franchisee For “Union Busting” Activities

Posted in Industry Updates, Legal Decisions

Last month the National Labor Relations Board (NLRB) ruled that a multi-unit Burger King franchisee violated the National Labor Relations Act (Act) by threatening pro-union employees with termination; maintaining a policy that denied access to off-duty employees to all areas of its premises and prohibited solicitation; and disciplining a pro-union employee for engaging in activity protected by the Act.

In 2013, multi-unit owner EYM King purchased a Burger King location in the Ferndale section of Detroit, Michigan which it operated along with 21 other Burger King franchisees located in high crime areas of the city.    Two of the employees already working for the Ferndale locations worked part-time for a union and engaged in strikes against the former franchisee owner.    The employees alleged that the franchisee violated the Act by engaging in union-busting activities.  The NLRB agreed.

The franchisee incorrectly stated on record that it believed it was ‘“plainly entitled’ to prohibit employees from discussing wages, unions or other protected activity during work time and to discipline for such conduct.”  Although an employer may prohibit employees from talking about union activity when they are on-the-clock, the rule must also extend to other subjects not connected to work tasks.  Since franchisee’s employees were free to discuss other subjects unrelated to work but not unionization, the franchisee’s policy violated the Act.

In addition, the franchisee’s excuse that it was located in a high-crime area as justification for its policy prohibiting access to off-duty employees to its premises and prohibiting solicitation was insufficient to meet the “special circumstances” criteria set by the Supreme Court.   The NLRB reasoned that if that were the case then it would “effectively deprive millions of the lowest-paid workers in the United States the ability to assert their Section 7 [Act] rights.”

One of the most interesting points of the decision is the franchisee sending home one of the pro-union employees early from her shift for failing to place pickles on sandwiches in perfect square.   The employee was able to show that her disciplinary action was related to her pro-union activity protected under the Act and the franchisee was unable to show that it would have sent the employee home for poor pickle placement in the absence of such activity.

Protests by fast-food workers over wages have made national headlines over the past year.  Fast food franchisees must be extra diligent in ensuring that its policies and practices do not violate workers’ rights under the Act or risk time-consuming and costly administrative actions.

Access Issues in Military Bases and Airports: Seattle ABA Forum on Franchising Annual Meeting Takeaway

Posted in Drafting Tips

Over the next few weeks we will be blogging on interesting takeaways from this year’s ABA Forum on Franchising Annual Meeting in Seattle, Washington.  I attended a very interesting and useful program on unique issues in alternative venues.  During the presentation an attendee brought up a fundamental issue facing franchise systems with franchisees located in airports and military bases:  ACCESS.  Security compliance in these alternative venues can make normally standard matters extremely complicated.

The franchisor and franchisee have to think about how each and their representatives are going to get their people and their products in and out.  Many leases in airports allow only the leasee access to the terminal or restricted area.   In one case, an attendee at the program in the audience mentioned that it was required to buy a ticket each time he wanted to send a representative in to inspect the franchise location – a mistake he said he’d never make again! In another case the audience member was required to maintain security clearances in 8 different airports and spoke about how onerous and cumbersome it was to keep these clearances current.  Finally, franchise systems have to consider how they will get products and equipment in and out as well.  Many airports and venues have strict guidelines for shipping products in and out of the restricted area.

The takeaway? Always negotiate security clearance issues and think about the practicalities of getting people in and out of the venue before entering into a franchise arrangement.

Antiquated Regulations Hobble Growth of Franchises in Food Truck Industry

Posted in Articles, Business Updates, Start-Up and Emerging Franchisors

The food truck industry is still hot and doesn’t appear to be slowing down.  The Four Seasons (yes, that Four Seasons) just recently begun a 9 city tour with its food truck offering its own upscale Philadelphia inspired menu including a “Victory Root Beer Phloat” with Tastycake Butterscotch Krimpet Ice Cream for dessert.   But is this continued craze translating to more food truck franchises?The Philadelphia Business Journal recently published an interesting article about the hurdles food trucks face in the city of Philadelphia.  The article delves into two big issues facing food trucks.  First, that city and county’s vending laws are often antiquated and fail to property represent today’s gourmet food truck movement.  Often the definition of a “mobile vendor” under these laws does not represent how modern food trucks operate resulting in onerous restrictions on where and when trucks may operate.   Or, in the case of the city of Houston, food trucks operating in the city cannot use industry standard propane and must operate within 500 feet of a flushable toilet.

Second, food trucks are facing competition from established brick and mortar restaurants using food trucks to give away free samples as part of marketing and advertising campaigns which can put an obvious cramp on businesses looking for paying customers.

My thoughts turned to franchising and whether there are many franchise systems out there having success with the food truck model.   The answer, for the time being, appears to be no.   Eric Silverstein, owner and operator of the Peach Tortilla food truck concept in Austin, Texas, wrote an interesting blog on food truck franchising last year.  He figured that lower start-up costs, the limited menu and easy to replicate concepts should work in favor of franchising.  However, like the Philadelphia Business Journal he also cites changing and non-uniform city laws as a major impediment to any serious growth in food truck franchising.

This is not to say that concepts are not trying. Many existing brands are having success adding trucks or mobile units as an additional option to prospective franchisees.  Franchise Hudson’s Coffee recently added a mobile food truck to its franchise offerings.   Although again, many of these brands use company owned food trucks initially only as a way to test markets and promote their brands.  There are not too many success stories of start-up concepts utilizing a purely mobile unit option.  However, this may change as outdated local laws are modernized to make it easier for food trucks to operate.  For now it appears that unclear laws and other factors will continue to thwart any significant growth of new mobile truck concepts.

Exorcise Your Cyber Demons (yeah, it’s National Cyber Security Awareness Month again)

Posted in Business Updates

It is October. And, while it is time for fall foliage–did you know Pennsylvania has 134 native tree species to New England’s 70?–ghosts, goblins and Halloween, the Federal Trade Commission reminds us that it is also time for National Cyber Security Awareness Month.

A lack of adequate cyber security measures for your business or home may in fact be scarier than a midnight showing of The Exorcist.

But there are a number of simple steps you can take this weekend to help keep your online life secure:

  1. Use security software–and keep it up to date. Threats change regularly.
  2. Keep your operating system and web browser up to date. This can be difficult, as IT departments worry about non-compliant software issues. But failing to update system and browsing software leaves “holes” for hackers.
  3. Create strong, long and unique passwords. Can’t remember them? Consider one of the many password managers available.

These small steps are the first steps to busting cyber crime.

Unknown Standards of Materiality Lead Governor Brown to Veto SB 610

Posted in Legislative Updates

In a follow up to our post on August 25, 2014, Governor Brown of California has vetoed SB 610, a bill which among other things would have made it considerably more difficult for franchisors to terminate franchisees in California and ended a franchisor’s right to approve certain franchisee transfers of their business. In his veto message, the Governor stated that “The bill’s changes would significantly impact California’s vast franchise industry”. His message states that he “needs a better explanation of the scope of the problem so I am certain that the solution crafted will fix those problems and not create new ones.” The Governor also noted that “the parties supporting and opposing this bill have dramatically different views” and that “it is in the interest of all that a concerted effort be made to reach a more collaborative solution.”

For the lawyers in our audience, Governor Brown’s veto message mentions in particular that the new standards of materiality (“substantial and material breach”) in the bill are unknown and the “good cause” standard is well-understood as a legal standard – indicating a potential concern that approval of this bill would produce additional litigation – a complaint voiced frequently by the International Franchise Association and others.  We agree with the Governor that this bill has always seemed to be a solution in search of a problem, and applaud his suggestion that all parties involved go back to the bargaining table and commit themselves to working toward a mutually amicable solution.